When companies are ready to list on the major stock exchanges, such as the New York Stock Exchange (NYSE) and the Nasdaq, they hold an IPO.
These are the first time many people have a chance to invest in the company, but it's not the most profitable time to invest.
Just think of Uber Inc. (NYSE: UBER), which listed on the NYSE in May.
It was one of the most hyped up IPOs of 2019, but the stock is down more than 20% since going public. The early investors were able to cash out for a profit, while the retail investors who bought at a high price can see a loss for months afterward.
There are times, for instance, that an IPO might never come back to the high-bid prices of the IPO.
But you don't have to be saddled with these losses by waiting for popular companies to hit the public market.
With pre-IPO investing, you don't have to worry about large institutional funds.
Benefits of Investing Pre-IPO
Pre-IPO investing starts when companies do, in the startup and early stages. Statistically, many fledgling companies fail because they don't have adequate funding. That's why they seek investors who can get a stake in the company for their funding.
There are synonyms for pre-IPO investing. Two are angel investing or first-stage funding.
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Angel investors or investors in the early stages are the people who invest when companies have a value of $5 million or under.
Sometimes angel investors are family members or friends of the startup founder. One of the most famous companies started by angel investors is Amazon.com Inc. (NASDAQ: AMZN). The founder, Jeff Bezos, asked 22 family members and friends for his initial capital in the mid-1990s. Currently, their stake is now worth more than $8.5 billion – an appreciation in the millions for those early angels.
What happens when companies are worth more than $5 million? Great question. There's a separate group of early-stage investors for those larger but still small firms. Venture capitalists deal with those startups.
Angel investors are usually individuals with some interest in the company, its sector, or its products. Venture capitalists usually work in large firms dedicated to finding firms that need venture capital and that may be (eventually) headed to IPOs.
Think you need big money to be an angel investor? At one time, that was undoubtedly true. However, with the start of the Angels and Entrepreneurs Network, retail investors can get the benefits of investing pre-IPO for just $50.
When Congress passed the JOBS Act in 2012, 240 million people in the united States became potential pre-IPO investors.
The benefits of investing pre-IPO are simple. You benefit as the startup company grows and becomes successful. Once it's successful enough to enter into an IPO, you sell into the excitement, rather than being on the receiving end of prices that rise too high as a result of excitement.
Investors pre-IPO own equity in the company, just as stock market investors do. Angel investing is frequently structured to be debt convertible to stock or preferred stock.
How to Get the Benefits of Investing Pre-IPO
In all investing, you want a plan that optimizes your reward and curtails your risk.
You want that just as much in pre-IPO investing, if not more so. Why? Because angel investing is riskier than post-IPO investing. Stocks that are well-capitalized and have been established may fluctuate, but they rarely see extreme downturns. Take Microsoft Corp. (NASDAQ: MSFT). It has had a thriving business for decades and provides investors with dividends that yield income even if the stock does fall.
However, angel investing is placing equity in a category of companies – startups – where a large percentage are known to fail. It's highly risky.
How do you limit losses as much as possible? By limiting the amount of money you place in pre-IPO investing. No more than 10% of your portfolio should be in early-stage investing because of its risks. The rest should be in growth and dividend stocks.
Then, you want to maximize growth by placing that 10% into many different companies. Angel investing, you see, thrives on multiple investments that heighten the probability that one or two will do really well. To have money in those winners, you may have to also have money in 8 or 9 losers, because it's a probability play.
And to get the most out of your angel investing, turn to the experts…